Posting On Comments

After my May Day request, some readers suggested that I comment on: a) value investing, b) the soundness of ETF sponsors and c) "where it is all going". Let me first thank you for taking the time to make these suggestions - please keep them coming.

Value investing

Made popular by such luminaries as Graham, Buffett, Templeton, Neff and others, it is a time-tested approach. However, it is not at all easy to identify "value"; apart from mechanical low p/e and p/bv approaches, it requires much slogging through financials, the understanding of the business involved and at least some sense of timing. One must also be very careful to distinguish between what may appear as "value" vs. a fundamental, permanent change in the economic worth of the enterprise due to a shift in technology, consumer tastes, etc. (eg buggy whips vs. steering wheels). In other words, a company's price may be low because its business is in permanent decline. Also, with powerful information technology now at everyone's fingertips, finding real diamonds in the rough has become extremely difficult.

Probably the best way to identify value is through your own daily experience. Keep your antennae up and try to find companies or sectors you are familiar with that are coming up with new or better products and services. My best personal example is of a friend who was a telecoms engineer years ago - he saw that a small, little-known company had come up with a very good product that his own company was buying in big numbers. So he bought shares in it. The small company was CISCO and the year was 1992.

Apart from the above, my other approach is to try to fathom fundamental macro shifts in the economy, identify the sectors that will benefit or suffer, find and analyze the appropriate sector leaders and invest accordingly (long or short). This is more of a cyclical approach to value, one that tries to take advantage of the ups and downs in the value perceptions of the investing public. For example, right now I believe the financial sector is overvalued, from a macro perspective.

ETF Sponsors

I must confess I am not crazy about ETF's and all other types of "packaged" or "indexed" products. They promote a passive style of investment I find personally not to my liking. Oh, they certainly have their uses in cases where individual share picking may be difficult or even impossible (eg country funds), but I prefer a more hands-on approach.

But the question was about the funds' sponsors... As long as they are large, reputable firms I don't really see much of a problem, unless there is a major blow-up. Naturally, one must always be wary of the annual fees and charges involved - they can be quite sizeable.

It's The End Of The World As We Know It (??)

A reader suggested that my comments frequently reach the edge of the precipice, but never go over it to proclaim the coming of a major financial crisis or meltdown. This is because I combine a data-driven economic analysis ("just the facts, ma'm") with a search for signs of psychological/emotional excess in markets ("fear and greed"). In the rare cases where both match, I look deeper and then act. For example, the copper madness of several months ago: prices had zoomed out of control but housing in the US was fast slowing down and people were getting electrocuted trying to steal high-voltage transmission wires: fundamental data plus people's folly pointed to shorting copper.

Right now the financial system in the US shows both kinds of negative signals: the economic data is coming in weak-ish and there is a party going on in Wall Street, albeit low-intensity (the drunken revelry is in Shanghai). But the individual investor is laying low in the US and Europe, having left the field to hedge and private equity funds who are maintaining the party through steady infusions of borrowed cash. They have a massive vested interest in keeping the party going, so it is difficult to say WHEN the party will be over and - most crucially - HOW it will end.

Usually, "smart" money takes a market to within 75-80% of the ultimate top and then unloads to the unsuspecting multitudes by creating a get-rich-quick euphoria that gooses the market the rest of the way. They typically unload after the crest, too, when individuals see the weakness as a "buying opportunity" and foolishly "double-down". We have not seen any of this yet in the US and Europe (though I strongly believe it is unfolding in China). What's more, I suspect we may not see this scenario play out in this market cycle: this time it may become a game just for the big boys, something straight out of the 19th century Gilded Age clashes between Morgan, Vanderbilt, "Diamond Jim" Burke, Jay Gould, et al. Certainly, the socio-economic climate is similar: monstrous gains for a few hundred "financiers" (some are making over a billion dollars a year) while the public is in huge debt, stockmarket takeover clashes are producing enormous bids, asset wealth is swamping income generation and so much more...

During the Gilded Age we got regular economic and market "panics" even though the public had very little participation in the bond and stock markets. They culminated in the Great Panic of 1893, which was the most serious to that point, with bank failures and very high unemployment.

So, in answer to your question, I suspect the current cycle will end with a 19th century-style panic after the "smartest" operators unload their paper on the "smart" ones. After all, there are now tens of thousands of hedge funds, private equity funds, asset managers, etc - and they can't ALL be "smartest". I bet 90% of them will end up holding the bag.

ADDENDUM: Of course, the wider public is already in this market through their pension funds - 30% of all investments in hedge funds are currently held by pension funds. That's 30% of $1.6 trillion, so we're talking serious money here. Individuals are in it, allright, they just don't know it.